Do You Know Bad Debt Is Allowable Deduction?

Introduction:

Bad debt is allowable deduction under the Afghanistan Income Tax Law if certain criteria are met. Here we explain the criteria for that as per the law and how it is applied in practice.

Bad Debt Expense:

Bad debt expense is the amount receivable from sales or receipts that is not recoverable and has been written off. In other words, bad debt expense is the way businesses account for a receivable account that will not be paid. Bad debt arises when a customer either cannot pay because of financial difficulties or chooses not to pay due to a disagreement over the product or service they were sold.
Bad debt expense is only a relevant consideration for accrual-basis taxpayers, because such taxpayers reported the invoice amount as revenue when the invoice was issued even though cash had not yet been received. This differs from a cash-basis taxpayer, who in their annual income tax return only will report the amount or revenue which has been collected.

Allowable Deduction Criteria:

As per the article 18 of the Afghanistan Income Tax Law, the bad debt is allowable deduction in annual income tax return if the following conditions are satisfied:

1. The amount of the debt was previously included in the taxable income of the taxpayer.
2. The debt is written off in the accounts of the taxpayer during the tax year.
3. The taxpayer has reasonable grounds for believing that the debt will not be recovered.

The above requirement will not apply to a bank entitled to a deduction for additions to reserves against losses in accordance to Article 56 of income tax law.

Remark: If an amount is written off as a bad debt, but the debtor subsequently pays some or all of the amount written off, then this amount will be treated as income.

Application in Practice:

The above criteria seem simple and should be easy to prove, but in practice the tax office requires taxpayers to prove that the bad debt amount is uncollectable. The burden of proof is on the taxpayer and the taxpayer cannot simply say that this receivable was overdue for more than year or two years. There should enough collection effort and documentation to show the amount is uncollectable. The tax office considers the following to be evidence of bad debt:

1. Legal action document, in which the court confirmed that the bad debt amount is uncollectable. The tax office wants the taxpayer claiming bad debt expense to have taken the case to court, even though this is beyond what the written tax law requires.
2. Other follow-up documents such as letters sent for collection.
3. The revenue list which shows this amount was reported by the taxpayer as revenue before the write-off.
4. Denial document (such as letter, email ) received from the party who owes the amount and refuses want to pay.

In this case the tax office put more weight on the third-party document, therefore the court document which show the legal action is their first priority requirement.